- Rhetoric about the tax bill has gotten disconnected from the way Americans are likely to feel the bill’s effects.
- At first, the tax bill would provide a tax cut to most Americans. Tax increases for many may come in later years.
- A near-term economic boost is likely.
- Added debt may slow the economy in the long run.
Since it’s looking pretty clear the Republican tax cut plan will become law, I think it’s worth walking through how it’s likely to be felt by Americans over the next few years, on their own tax returns, and in the broader economy.
The centerpiece of the plan is a permanent reduction in the corporate tax rate from 35% to 20%. The plan also reduces individual tax rates somewhat, while eliminating various tax preferences and deductions.
There’s been a lot of focus on how the plan would eventually impose tax increases on huge swathes of the population – by 2027, the Tax Policy Center found 48% of tax filers would face tax increases, while only 31% would get a tax cut, relative to current law. This is because most of the personal income tax cuts in the bill are set to expire after a few years, in order to comply with complex Senate budget rules.
Future Congresses may act to avert many of these tax increases by extending the tax cuts – though doing so would add even more to the federal debt than the $1 trillion-plus set to be added by this bill.
But that’s a question that won’t be resolved until a few years in the future.
In the near term, the bill will give most Americans a tax cut. It’s also likely to boost the economy at least a little bit over the next couple of years – though its positive economic effects will fade over time, and may even turn negative by the end of the decade, depending on which analysis you believe.
At first, the bill provides a tax cut to most Americans
- Zach Gibson/Getty Images
Under the Senate version of the tax bill, most of the individual income tax cuts are set to become effective in 2018, while the corporate tax cuts become effective in 2019. And according to that Tax Policy Center analysis, 75% of American tax units* would get a tax cut under the Senate tax bill in 2019 – the first year most of the cuts are in full effect.
The average tax savings for a tax unit in the middle-income quintile – that is, reporting income between $49,600 and $87,400 – would be $840.
But there’s a key caveat. Much of that savings is attributable to the cut in corporate income tax. Individuals benefit from a corporate income tax cut to the extent they have investments. TPC also believes they benefit because a portion of the corporate income tax – 20%, in TPC’s estimation – is borne by workers in the form of lower wages.
So, much of the tax savings won’t show up as a reduction in tax withholding. It will show up as an increase in stock prices and in wages – possibly, if TPC’s economic assumptions are right, and if other factors (such as Federal Reserve policy) do not interfere with wage growth.
Still, even setting aside the corporate tax, a clear majority of Americans who pay income tax will see a cut in their own, personal income taxes in 2018 and 2019 under the Senate plan. Many low-income workers, who already pay no income tax, would see their personal taxes unchanged; they might enjoy some small, spillover economic benefits from the corporate tax cuts.
TPC believes 7% of Americans will be facing a tax increase even in 2019, the year when the Republican tax package is scheduled to be at its most generous.
Often, these are taxpayers who make extensive use of deductions that would be eliminated under the plan, such as the deduction for state and local income taxes paid.
The tax changes would become apparent to people at different times
- Thomson Reuters
The first sign of the tax changes should show up in workers’ paychecks in January, when employers adjust tax withholding to reflect lower (or, in the case of an unfortunate few, higher) tax liability.
But the link between the tax bill and a change in take-home pay may not be obvious to all workers, because lots of other factors can cause take-home pay to change in January.
For example, some workers (including federal employees) get annual raises on January 1. Employers may change health insurance plan terms and associated payroll deductions at the start of the year. Workers who make over $127,200 stop paying Social Security taxes mid-year, once they hit the tax cap; Social Security tax will resume being deducted from their paychecks in January.
All of which is to say, it won’t necessarily be obvious to workers that changes in their paychecks are related to the tax bill.
Workers will get a more complete view of how the tax changes have affected them when they file their 2018 income taxes in 2019.
Of course, people may also attribute general economic conditions, including stock prices, employment and wage growth, to the tax bill.
The direct effects of the tax plan become less favorable over time
As the years pass, some of the value of the tax cuts will be eaten away by inflation.
The Republican bill would change the way tax brackets are adjusted for inflation annually, making the adjustment less favorable to taxpayers. The bill also proposes to double the child tax credit, but does not adjust the tax credit for inflation; since the higher-but-unadjusted credit replaces the existing, inflation-adjusted personal exemption, this swap becomes less favorable to taxpayers over the years.
These changes will be slow and gradual, and likely wouldn’t be directly noticeable to most taxpayers.
Many of the personal income tax-cut provisions in the bill are also scheduled to expire within the next 10 years. These expirations were designed to meet fiscal targets around the bill: To comply with Senate rules, the bill had to increase the budget deficit by no more than $1.5 trillion over a decade and not at all thereafter.
Many Republican officials have expressed their intention to extend these tax cuts later, even though doing so would add more federal government debt. But Congress will have to act to extend them, and that action could be complicated by political or economic circumstances that arise in the future.
If any of the tax cuts are allowed to expire, that would lead to a sudden increase in many people’s taxes that will be noticeable.
The bill’s economic benefits are front-loaded, with costs later
- Carlos Barria/Reuters
If you ask eight economists, you might get nine different opinions about how this tax bill will affect the economy.
Congress’ official tax scorekeeper, the Joint Committee on Taxation, estimated the bill would have modest, positive effects on economic growth, making the economy on average 0.8% larger over the next decade. The Tax Policy Center found somewhat more modest positive effects than that, and Goldman Sachs even more modest than TPC.
Some forecasts preferred by conservatives predict larger effects, but you’d have to squint really hard even at these optimistic forecasts to come to the conclusion some Republican officeholders have for some reason been offering confidently: that the bill will grow the economy enough to fully offset its revenue loss.
If you talk with liberal economic experts, some of them will tell you they think the bill won’t grow the economy at all.
But one thing the forecasts tend to have in common is their projection of trends over time: They think the bill’s economic effects would be most positive over the next two years, as capital expensing provisions encourage businesses to buy new buildings and equipment, and as the economy enjoys a Keynesian boost from higher deficits.
The bill’s effect on the economy is projected to become less positive, or even negative, in later years, as those temporary expensing provisions expire and higher government debt weighs on the economy.
One reason to think any economic costs from the law aren’t likely to surface immediately is this: Usually, the key way a deficit-increasing tax cut would hurt the economy is because higher government borrowing would push up interest rates and crowd-out private sector economic activity. But with interest rates extremely low and business investment mostly limited by businesses not knowing what to do with the capital they’re awash in, this effect may be smaller now than the textbook models would tell you.
That said, negative economic effects could be felt if the Federal Reserve feels compelled to respond to wage gains or faster economic growth by raising short-term interest rates. In the long run, the interest rate environment may change and make high government debt more costly. Higher government debt could also make it harder to respond effectively to a future economic crisis.
All of which is to say, there are reasons to worry the deficits from the tax bill will come back to bite us eventually. But probably not in 2018 or 2019.
*A “tax unit” is the person or group of people represented on a personal income tax return – typically, a single individual or a married couple.